Johnson v. Commissioner
78 T.C. 882, 1982 U.S. Tax Ct. LEXIS 91, 78 T.C. No. 62 (1982)
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Rule of Law:
For a corporation, rather than its service-performing employee, to be considered the earner of income for tax purposes, there must be a contract between the corporation and the entity using the services that recognizes the corporation's controlling position over the employee.
Facts:
- Charles Johnson, a professional basketball player for the San Francisco Warriors, signed an agreement on August 16, 1974, with Presentaciones Musicales, S.A. (PMSA), a Panamanian corporation.
- This agreement gave PMSA the exclusive right to Johnson's services in professional sports for six years in exchange for a monthly payment of $1,500.
- PMSA then licensed its rights and obligations regarding Johnson's services to EST International Ltd. (EST), a British Virgin Islands company.
- When negotiating a new contract for Johnson, the Warriors organization was adamant about using an NBA Uniform Player Contract and refused to sign any agreement with PMSA or EST.
- On August 27, 1974, Johnson signed a standard two-year employment contract directly with the Warriors.
- The Warriors, while refusing to contract with EST, agreed they would remit Johnson's salary payments to a different entity if Johnson legally assigned the payments.
- On April 25, 1975, Johnson executed an 'Assignment of Contract Rights,' directing all payments from his Warriors contract to be made to EST.
- Johnson subsequently signed several more direct employment contracts with the Warriors and later the Washington Bullets, and all payments due under these contracts were sent to EST.
Procedural Posture:
- Charles Johnson (petitioner) reported payments from EST as business income on his 1975, 1976, and 1977 tax returns, rather than as wages from the Warriors.
- The Commissioner of Internal Revenue (respondent) issued notices of deficiency, determining that all amounts paid by the Warriors constituted income to Johnson.
- Johnson challenged the deficiencies by filing petitions in the U.S. Tax Court.
- The cases were consolidated for trial in the U.S. Tax Court.
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Issue:
Are compensation payments made by a professional basketball team to a third-party corporation, pursuant to a player's assignment of rights, taxable as income to the player when the team insists on a direct employment contract with the player and refuses to contract with the third-party corporation?
Opinions:
Majority - Fay, Judge
Yes. The compensation payments are taxable as income to the player. Under the foundational principle of Lucas v. Earl, income must be taxed to the one who earns it. For a corporation to be considered the earner of income instead of its service-performing employee, a two-part test must be satisfied. First, the service-performer must be an employee whom the corporation has a right to control in a meaningful sense. Second, and crucially in this case, a contract must exist between the corporation and the entity using the services which recognizes the corporation's controlling position. Here, the second element is absent. The Warriors adamantly refused to enter into any contract with PMSA or EST, contracting only with Johnson directly. Therefore, Johnson was the party who controlled the earning of the income, and the assignment of his salary to EST was merely an anticipatory assignment of income that does not shift the tax burden.
Analysis:
This decision clarifies the application of the assignment of income doctrine to 'loan-out' corporations commonly used by athletes and entertainers. It establishes a clear, two-part test, with the second prong—the existence of a contract between the loan-out corporation and the service user—being a critical requirement. The ruling limits the ability of individuals to shift tax liability through such corporate structures if the ultimate payor for the services is unwilling to contract directly with the corporation. This reinforces that the substance of the employment relationship, defined by the contracts between the parties, governs who is the true earner of the income for tax purposes.
